Edited version of private advice

Authorisation Number: 1051942498747

Date of advice: 28 January 2022

Ruling

Subject: Return of capital and dividend

Question 1

Will the return of capital constitute a dividend as defined in subsection 6(1) of the ITAA 1936 and the exclusion under section 6(4) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No

Question 2

Will the Commissioner make a determination under subsection 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 applies in relation to the whole or part of the return of capital amount?

Answer

No

Question 3

Will the Commissioner make a determination under subsection 45B(3)(b) of the ITAA 1936 that section 45C of the ITAA 1936 applies in relation to the whole or part of the return of capital amount?

Answer

No

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Background

Company A is an Australian tax resident public company listed on the Australian Securities Exchange (ASX). It is the head company of the Company A group.

Company A was incorporated and listed on the ASX after 20 September 1985.

All shares on issue by Company A are ordinary shares.

Company A's share capital account is a share capital account for income tax purposes in accordance with subsection 975-300(1) of the Income Tax Assessment Act 1997 (ITAA 1997). Further, Company A's share capital account is not tainted within the meaning of section 197-50 of the ITAA 1997.

Company A satisfies the definition of 'widely held company' in accordance with section 995-1 of the ITAA 1997.

As of Month 20XX, a large majority of Company A's shareholder base consisted of Australian shareholders. Further, Australian shareholders held the large majority of Company A's total share ownership. The non-resident shareholding amount of Company A is not sufficient to influence, or to confer control of, the company.

Company A does not hold sufficient Australian real property for the shares to pass the principal asset test. Therefore, Company A shares are not taxable Australian property under table item 2 in section 855-15.

In recent years, there has been no interruption to the normal pattern of profit distributions and franking percentages thereof that have been paid by Company A shareholders by Company A.

The Sale

Company A sold two of its overseas groups to Company B (the Sale). These two overseas groups constituted Company A's main undertaking and was a significant part of its business. Therefore, capital became permanently surplus to Company A's requirements.

Company A's intention is to delist from the ASX and ultimately wind up its remaining entities.

The return of capital and special dividend

Following the Sale, Company A distributed the net proceeds (less transaction costs and other amounts associated with the disposed businesses) to its shareholders by way of a combination of equal capital reduction and special dividend.

The return of capital and special dividend were distributed in one payment, comprising the two components, to all shareholders pro rata to the number of shares they held at the Record Date.

Overview of the return of capital

The return of capital constituted an equal reduction of Company A's share capital for the purposes of the Corporations Act.

The return of capital was affected as a pro-rata / equal capital reduction.

All Company A shareholders at the Record Date received the same return of capital payment of $XX per share and the same special dividend of $YY per share.

All Company A shareholders at the Record Date received the return of capital on the same terms irrespective of their tax profile and without regard to whether the shareholder derived a greater benefit in accordance with circumstances in subparagraph 45A(3)(b) of the ITAA 1936 from the return of capital.

No shares were cancelled in connection with the equal capital reduction and no fractional entitlements arose.

Company A did not raise share capital as part of the return of capital.

Company A did not provide ownership interests as part of the return of capital to its shareholders.

Overview of the special dividend

The amount of the special dividend was the excess of the total distribution over the capital component (as calculated using the slice approach).

The special dividend was unfranked and ZZ% of the unfranked dividend was declared as conduit foreign income.

Company A distributed the special dividend out of current period net profits. This included the accounting profit from the Sale.

Calculation of the distribution under the Slice Approach

Company A adopted the 'slice approach' as outlined in paragraph 73 of Practice Statement Law Administration PSLA 2008/10: Application of section 45B of the Income Tax Assessment Act 1936 to share capital reductions (PS LA 2008/10) to determine the allocation between capital invested by Company A in the disposed businesses and the respective dividend.

Under the 'slice approach', the amount of capital invested in the disposed businesses was determined by the ratio of market value of the disposed businesses to the market value of the Company A group.

Relevant legislative provisions

•                    the Income Tax Assessment Act 1936 (ITAA 1936) Subsection 6(1)

•                    the ITAA 1936 section 45A

•                    the ITAA 1936 section 45B

•                    the ITAA 1936 Section 45C

•                    the Income Tax Assessment Act 1997 (ITAA 1997) section 104-25

•                    ITAA 1997 section 104-135

•                    ITAA 1997 Division 197

•                    ITAA 1997 section 197-50

•                    ITAA 1997 section 975-300

•                    ITAA 1997 995-1(1)

Reasons for decision

Question 1

Summary

The return of capital by Company A was not a dividend as defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) for income tax purposes.

Detailed reasoning

The term 'dividend' is defined in subsection 6(1) of the ITAA 1936 and includes any distribution made by a company to any of its shareholders, whether in money or other property (paragraph (a) of the definition). The payment of money under the return of capital satisfies this definition.

However, paragraph (d) of the definition of 'dividend' in subsection 6(1) of the ITAA 1936 excludes money paid by a company to a shareholder where the amount of the money paid is debited against an amount standing to the credit of the share capital account of the company.

Subsection 6(4) of the ITAA 1936 provides that the definition of a dividend in paragraph 6(1)(d) of the ITAA 1936, where the distribution involves an arrangement under which a company credits its share capital account as a result of money or property provided by a person and then makes a distribution from the share capital account to another person. Subsection 6(4) of the ITAA 1936 is not applicable as Company A did not raise share capital as part of the Return of Capital.

The return of capital was debited in full against Company A's share capital account. Company A's share capital account (as defined in section 975-300 of the ITAA 1997) is not tainted (within the meaning of Division 197 of the ITAA 1997).

Therefore, the entire amount of the return of capital was not a 'dividend' as defined in subsection 6(1) of the ITAA 1936.

Question 2

Summary

The Commissioner will not make a determination under subsection 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 applies in relation to the whole, or any part, of the return of capital.

Reasoning

Section 45A

Section 45A of the ITAA 1936 applies when a company streams the provision of capital benefits to shareholders who would derive a greater benefit from the capital benefits than other shareholders and it is reasonable to assume that the other shareholders have received, or will receive, dividends (subsection 45A(1) of the ITAA 1936).

The term 'streaming' is not defined in either the ITAA 1936 or the ITAA 1997. In general, streaming refers to a strategy of selectively directing a certain type of benefit to those entities which will derive the greatest advantage (for particular tax purposes) from that benefit as opposed to another type of benefit.

In the context of section 45A of the ITAA 1936, streaming describes arrangements where capital benefits are allocated to shareholders who have a preference for capital, with all other shareholders receiving dividends. The circumstances in which a shareholder would derive a 'greater benefit' from capital benefits are listed (but not exhaustively) in subsection 45A(4).

The phrase 'provision of a capital benefit' to a shareholder in a company is defined in subsection 45A(3) of the ITAA 1936 and includes the distribution to the shareholder of share capital (paragraph 45A(3)(b)). The share capital paid to Company A shareholders under the return of capital means that there was the provision of a capital benefit to Company A shareholders.

In this case, the following factors are relevant in determining whether there was a streaming of capital benefits to Company A shareholders:

•                    the return of capital was affected as a pro-rata / equal capital reduction.

•                    all Company A shareholders at the Record Date received the same return of capital payment of $XX per share and the same special dividend of $YY per share.

•                    company A is a widely held public company.

•                    all Company A shareholders at the Record Date received the return of capital on the same terms irrespective of their tax profile and without regard to whether the shareholder would derive a greater benefit in accordance with circumstances in subparagraph 45A(3)(b) of the ITAA 1936 from the return of capital.

In consideration of the above factors, the Commissioner is satisfied that there was no streaming of capital benefits. Accordingly, the Commissioner will not make a determination under subsection 45A(2) that section 45C applies in relation to the whole, or a part, of the capital benefit provided to Company A shareholders. No part of the reduction of share capital will be treated as a dividend for income tax purposes under section 45A.

Question 3

Summary

The Commissioner will not make a determination under paragraph 45B(3)(b) of the ITAA 1936 that section 45C of the ITAA 1936 applies in relation to the whole, or any part, of the return of capital.

Section 45B

Section 45B of the ITAA 1936 applies where certain capital benefits are, having regard to the relevant circumstances of the scheme in subsection 45B(8), considered to have been provided to shareholders by a company for a more than incidental purpose of enabling a taxpayer to obtain a tax benefit.

Where section 45B applies, the Commissioner may make a determination that all or part of the capital benefit is taken to be a dividend paid by the company for income tax purposes. Under subsection 45B(2), the Commissioner will make the relevant determination where:

•                    there is a scheme under which a person is provided with a capital benefit by a company (paragraph 45B(2)(a)),

•                    under the scheme, a person (the relevant taxpayer), who may or may not be the person provided with the capital benefit, obtains a tax benefit (paragraph 45B(2)(b)), and

•                    having regard to the relevant circumstances of the scheme, it would be concluded that a person who entered into or carried out the scheme or any part of the scheme did so for a more than incidental purpose of enabling the relevant taxpayer to obtain the tax benefit (paragraph 45B(2)(c)).

Scheme

Subsection 45B(10) provides that, in section 45B, 'scheme' has the meaning given by subsection 995-1(1) of the ITAA 1997. That term means any arrangement (itself defined by subsection 995-1(1) of the ITAA 1997 as any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings), or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

The payment of the return of capital by Company A to its shareholders is a scheme for the purposes of section 45B.

Under which a person is provided with a capital benefit by a company

The phrase 'provided with a capital benefit' is defined in subsection 45B(5) of the ITAA 1936.

As the reduction of share capital is a distribution to the shareholders of Company A of share capital, Company A has provided its shareholders with a capital benefit under paragraph 45B(5)(b) of the ITAA 1936.

A taxpayer obtains a tax benefit

Under subsection 45B(9) of the ITAA 1936, a relevant taxpayer 'obtains a tax benefit' if an amount of tax payable by the relevant taxpayer would, apart from section 45B, be less than the amount that would have been payable, or would be payable at a later time than it would have been payable, if the capital benefit had been an assessable dividend.

From a resident shareholder's perspective, the return of capital is only assessable in the hands of an Australian resident shareholder, to the extent that a capital gain arises under CGT event G1. Any capital gain is taxable if the return of capital exceeds the cost base of the shares and the amount may be reduced by the CGT discount. If the capital benefit had been an assessable dividend, it would have been included in the assessable income of all resident shareholders, on which tax would be payable.

Non-residents, on the other hand, are not exposed to capital gains on the disposal of shares unless those shares are not 'taxable Australian property' as defined in section 855-15. Item 2 under section 855-15 is the only relevant item to Company A's circumstances in this case. Item 2 defines taxable Australian property to include an indirect Australian real property interest.

Subsection 855-25(1) provides that a membership interest held by an entity (the holding entity) in another entity (the test entity) at a time is an indirect Australian real property interest at that time if:

(a)          the interest passes the non-portfolio interest test (see section 960-195):

(i)            at that time; or

(ii)           throughout a 12-month period that began no earlier than 24 months before that time and ended no later than that time; and

(b)          the interest passes the principal asset test in section 855-30 at that time.

The principal asset test under subsection 855-30(2) of the ITAA 1997 is as follows:

A membership interest held by an entity (the holding entity) in another entity (the test entity) passes the principal asset test if the sum of the market values of the test entity's assets that are taxable Australian real property exceeds the sum of the market values of its assets that are not taxable Australian real property.

To the extent that a non-resident shareholder, either alone or together with any associates, beneficially hold (or have held at any time in the previous 12 months) less than 10% of Company A shares, the non-portfolio interest test will not be satisfied and therefore, the Company A shares will not be an indirect Australian real property interest for those shareholders.

Company A shares do not constitute 'taxable Australian property of non-resident shareholders in accordance with table item 2 of section 855-15 of the ITAA 1997. Accordingly, the return of capital is not assessable in the hands of non-resident shareholders.

To the extent the unfranked special dividend was not declared to be conduit foreign income, Company A's non-resident shareholders will obtain a tax benefit if the distribution was a capital return rather than an unfranked dividend as there is no withholding tax imposed on the return of capital. The rate of withholding tax varies depending on the non-resident shareholders country of tax residence in accordance with subsection 128B(1) of the ITAA 1936 and the relevant double tax treaty.

Therefore, under the scheme, a taxpayer (the relevant taxpayer, being some of the shareholders of Company A) will obtain a tax benefit in accordance with subsection 45B(9) of the ITAA 1936.

The relevant circumstances

Paragraph 45B(2)(c) of the ITAA 1936 requires the Commissioner to consider the 'relevant circumstances of the scheme', which are listed (non-exhaustively) in subsection 45B(8) of the ITAA 1936, in order to reach an objective conclusion about whether a person who entered into or carried out the scheme or any part of the scheme did so for a more than incidental purpose of enabling the relevant taxpayer to obtain a tax benefit

Each of the relevant circumstances under subsection 45B(8) are examined below.

Paragraph 45B(8)(a) - the extent to which the capital benefit is attributable to capital or profits (realised and unrealised) of the company or of an associate (within the meaning in section 318 of the ITAA 1936) of the company

Paragraphs 61, 63 and 73 of PS LA 2008/10 state:

61. The inquiry contemplated by the words 'attributable to' is essentially a practical one concerned with determining whether there is a discernible connection between the amount distributed as share capital and the share capital and profits that are realistically available for distribution, including the profits of an associate of the company. The connection need not be that of a sole, dominant, direct or proximate cause and effect; a contributory causal connection is sufficient.

63. A capital distribution that is attributable to share capital should reflect circumstances which show that the share capital distributed is genuinely surplus to the company's need of it and that it is not merely a cash distribution debited against share capital on the basis of shareholder tax preference. For instance, the capital distribution may coincide with the disposal of a significant part of the business structure which can be identified as releasing share capital. However, if the disposal also realises a profit the ensuing distribution should, subject to all the other relevant circumstances, be considered in terms of its attribution to both share capital and the profit from the disposal.

73. As discussed at paragraph 57 in PS LA 2005/21, if the capital distribution is attributable to the disposal of assets of the business, a reasonable approach should be taken in determining the extent to which share capital was invested in the disposed assets and is available to be distributed to shareholders. In some instances the capital may be traced directly to the asset and in others it may be a matter of inferring its allocation on a reasonable basis. For example, it may be appropriate to allocate capital across the enterprise as a whole, based on valuing assets according to their market value. This is sometimes referred to as the 'slice approach' to the compilation of assets as between capital and profit. (emphasis added).

Company A sold two of its overseas groups to Company B (the Sale). These two overseas groups constituted Company A's main undertaking. The proceeds of the Sale were distributed to shareholders with both a capital return and a special dividend component.

Company A adopted the 'slice approach' to determine the amount of capital and dividend. Under the 'slice approach', the amount of capital invested in the disposed businesses was determined by the ratio of market value of the disposed businesses to the market value of the Company A group.

The Commissioner accepts that the share capital attributable to the Sale under the slice approach is acceptable. This is on the basis that capital became surplus to Company A's requirements following the Sale. Since it is considered that no part of the capital return is attributable to profits, this circumstance does not incline towards a conclusion that the requisite purpose exists.

Paragraph 45B(8)(b) - the pattern of distributions of dividends, bonus shares and returns of capital or share premium by the company or by an associate (within the meaning in section 318 of the ITAA 1936) of the company

This factor examines the pattern of distributions by the company. Paragraph 77 of PS LA 2008/10 states:

The inference here is that an interruption to the normal pattern of profit distribution and its replacement with a distribution of capital may suggest dividend substitution. It may become apparent after having regard to the general pattern of distributions of the company that the company has a pattern of making capital distributions (with the capital performing the function of dividends).

In recent years, there has been no interruption to the normal pattern of profit distributions paid by Company A shareholders by Company A. Aside from these distributions, Company A paid the special dividend to shareholders that was attributable to the sale proceeds of the Sale. The amount of the special dividend was the excess of the total distribution over the capital component (as calculated using the slice approach). Therefore, it cannot be said that the capital component itself was in substitution of a dividend.

This factor does not incline towards the existence of the requisite purpose.

Paragraph 45B(8)(c) - whether the relevant taxpayer has capital losses that, apart from the scheme, would be unutilised (within the meaning of the ITAA 1997) at the end of the relevant year of income

Company A is a widely-held public company listed on the ASX. Therefore, it is unable to determine the income tax status of each resident shareholders to determine whether they have carried forward capital losses that could have been used to offset any capital gain. In addition, all shareholders at the Record Date received the return of capital, irrespective of whether they have capital losses or not.

Therefore, this aspect does not indicate or point to a more than incidental purpose of obtaining a tax benefit. This factor does not incline towards the requisite purpose.

Paragraph 45B(8)(d) - whether some or all of the ownership interests in the company or in an associate (within the meaning in section 318 of the ITAA 1936) of the company held by the relevant taxpayer were acquired, or are taken to have been acquired, by the relevant taxpayer before 20 September 1985

Where relevant taxpayers who are shareholders receive a capital distribution in respect of a pre-CGT share, there would ordinarily be no CGT consequences for the shareholder. This could influence the company's decision to distribute share capital, particularly if a large proportion of the shares in the company are pre-CGT assets of shareholders.

Company A was incorporated and listed on the ASX after 20 September 1985. Therefore, no shares in Company A have been acquired by the relevant taxpayer before 20 September 1985. Therefore, this factor is not applicable.

Paragraph 45B(8)(e) - whether the relevant taxpayer is a non-resident

The implication of being a non-resident is that it would normally point towards a tax preference for a distribution of capital over a dividend. Non-resident shareholders are subject to dividend withholding tax (normally at the rate of 15%, although the rate varies depending on the country of tax residence of each non-resident shareholder), which necessarily excludes a distribution of capital.

Non-residents are also not taxed on capital gains from shares (CGT event G1 happens when there is a distribution of share capital) if those shares are not an 'indirect Australian real property interest' as defined in section 855-25 of the ITAA 1997.

As of Month 20XX, a large majority of Company A's shareholder base consisted of Australian shareholders. Further, Australian shareholders held the large majority of Company A's total share ownership. Company A's non-resident shareholders are likely to be preferentially taxed on a capital distribution they receive compared to a dividend they receive from Company A to the extent that the shares in Company A are not 'taxable Australian property' (section 855-10 of the ITAA 1997).

The Commissioner accepts the non-resident shareholding amount of Company A is not sufficient to influence, or to confer control of, the company. Given that the return of capital was made to all Company A shareholders, this factor does not incline towards the requisite purpose.

Paragraph 45B(8)(f) - whether the cost base (for the purposes of the ITAA 1997) of the relevant ownership interest is not substantially less than the value of the applicable capital benefit

Where the cost base of the Company A shares was of a similar or greater value than the value of the capital benefit provided to shareholders, the capital benefit (being a distribution of share capital) does not result in a capital gain under CGT event G1.

By contrast, a dividend of the same amount would be included in the assessable income of Australian resident shareholders for the income year (or give rise to dividend withholding tax for non-resident shareholders to the extent that the distribution that was not characterised as conduit foreign income (see section 802-15 of the ITAA 1997). The opportunity to defer the taxing point for its shareholders could influence the company's decision to pay a distribution of share capital.

As Company A is a widely-held company listed on the ASX, it is unable to determine the cost base of each share on issue.

Accordingly, paragraph 45B(8)(f) does not incline towards the existence of the requisite purpose.

Paragraph 45B(8)(h) - if the scheme involves the distribution of share capital or share premium, whether the interest held by the relevant taxpayer after the distribution is the same as the interest would have been if an equivalent dividend had been paid instead of the distribution of share capital or share premium

PS LA 2008/10 states:

89. ... This matter examines the effect of the capital reduction on the substance of the shareholder's interest in the company directly and relative to other shareholders.

90. This relevant circumstance proceeds from the premise that when a dividend is paid the shareholder's interest remains unchanged, and that a distribution of capital made in similar circumstances may be performing the same function as a dividend and be made in substitution for it. It has regard not only to whether there has been a cancellation or variation in the shareholder's interest, but also to whether the shareholder's interest has remained the same comparative with other shareholders.

91. An equal share capital reduction under which no shares are cancelled (often called a pro-rata return of capital) does not affect the shareholder's substantive interests, either individually or inter se and thus the interests remain the same as if a dividend had been paid instead. From the shareholders' perspective a reduction of capital without a cancellation of shares is not dissimilar economically to a special dividend in that cash is distributed to them while they retain the share with all of its rights intact.

While Company A's share capital balance was reduced as a result of the return of capital, each shareholder's proportionate interest remains unchanged immediately after the return of capital.

Accordingly, considered in isolation, this factor inclines towards the existence of the requisite purpose.

Paragraphs 45B(8)(i) and (j) - not relevant

These factors are not relevant to this case as the return of capital by Company A did not involve:

•                    the provision of ownership interests and the later disposal of those interests (paragraph 45B(8)(i)); or

•                    a demerger (paragraph 45B(8)(j)).

Paragraph 45B(8)(k) - any of the matters referred to in subsection 177D(2) of the ITAA 1936

Paragraph 177D(2)(a) - the manner in which the scheme was entered into or carried out

Paragraph 101 of PS LA 2008/10 states:

This is a reference to consideration of the way in which a method or procedure by which the particular scheme in question was established; in other words consideration of the decisions, steps and events that combine to make up the scheme.

A large portion of the net cash proceeds from the Sale (comprising the disposal of its main undertaking and a disposal of significant part of its business) were permanently surplus to Company A's requirements. Company A intends to wind up its operations. For this reason, it decided to return some of its share capital to its shareholders in the manner prescribed by the Corporations Act 2001 (the only legal way that it can return share capital).

The manner in which the scheme was entered into or carried out is consistent with the commercial rationale, and thus does not incline towards the existence of the requisite purpose.

Paragraph 177D(2)(b) - the form and substance of the scheme

Paragraph 102 of PS LA 2008/10 states:

The form of the scheme is the visible aspect of the scheme; the substance of the scheme is its essential nature which is normally determined from its commercial and economic implications.

A share capital reduction, a distribution of share capital, would constitute the form of a scheme and the substance of it would be determined from the effects of the scheme on the commercial and economic circumstances of the shareholders and the company. For example, where a company returns excess capital, which is referable to a disposal of part of its business, as long as the amount returned to shareholders is attributable to the share capital invested in that part of the business, the substance of the scheme would accord with its form.

The form of the scheme was a distribution of share capital in the manner prescribed by the Corporations Act 2001.

The substance of the scheme is determined from the effects of the scheme on the commercial and economic circumstances of the shareholders and the company.

The purpose of the return of capital is for Company A to return the capital that it invested in the businesses that were sold on the basis that Company A no longer required these funds following the Sale. This factor is analogous to the example provided in paragraph 103 of PSLA 2008/10 where it was stated that in the case of a return of excess capital referable to a disposal of part of its business to shareholders, the substance of the scheme would accord with its form. The substance of the scheme accords with its form, and thus, does not incline towards the existence of the requisite purpose.

Paragraph 177D(2)(c) - the time at which the scheme was entered into and the length of the period during which the scheme was carried out

Paragraph 104 of PS LA 2008/10 states:

This factor requires not only reference to time measurement but also reference to the timing of the scheme from the point of view of the scheme's coincidence with events or circumstances beyond the scheme itself. In particular, it enables consideration of the extent to which the timing and duration of the scheme go towards delivering the relevant tax benefit or are related to commercial opportunities or requirements.

As the return of capital was directly attributable to the disposal of Company A's main undertaking, the timing can be considered in the context of the Sale. Company A distributed the net proceeds (less transaction costs and other amounts associated with the disposed business) to its shareholders by way of the return of capital and special dividend.

The timing of the capital return subsequent to a substantial disposal and consideration that the share capital has become surplus to the company's requirements does not support a view that the timing was in support of obtaining a tax benefit for its shareholders.

Paragraph 177D(2)(d) - the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme

Paragraph 108 of PS LA 2008/10 states:

... the most sensible construction of the words of subparagraph 177D(b)(iv) [now paragraph 177D(2)(d)] is to read 'this Part' to mean 'this section'. The issue then becomes a matter of identifying the tax results of the scheme if section 45B were not to apply.

The income tax outcome of a reduction of share capital is always the same, as stated in paragraph 109 of PS LA 2008/10:

The more immediate result under the ITAA 1936 and ITAA 1997 of a share capital reduction is that because the distribution is debited against the company's share capital account the distribution carries the tax advantage of falling outside the definition of dividend in subsection 6(1) of the ITAA 1936, and is not received as income in the shareholder's hands. Instead, in the case of a pro-rata return of capital which involves no cancellation of shares the cost base of the affected shares will be reduced by the amount of the capital returned under CGT event G1, and shareholders will realise a capital gain to the extent that the capital distribution exceeds the shareholder's cost base in the shares.

Paragraph 177D(2)(d) considers what the income tax outcome would be under the scheme if section 45B was not applicable. In this case, the gain made by the relevant shareholder would be based on the cost base of the shares. On balance, it is possible that some shareholders would make a gain whilst others would not.

While resident shareholders are the majority, there are a number of non-resident shareholders who will not make a capital gain, even if the cost base of their shares is eliminated and CGT event G1 happened, because of section 855-10. Furthermore, dividend withholding tax under section 128B will not be applicable to the capital return because it was not a dividend.

For the purposes of paragraph 177D(2)(d), if section 45B did not apply, the return of capital would be debited against the share capital account of Company A and would not constitute a dividend under subsection 6(1), meaning:

•                    for resident shareholders

o        the payment will not be included in their assessable income under section 44.

o        CGT event G1 happened in respect of the payment and the cost base of their shares will be reduced by the amount of the capital returned. There is potential for shareholders to realise a capital gain to the extent the capital distribution exceeded their cost base in the shares.

•                    for non-resident shareholders

o        the distribution will not be subject to the dividend withholding tax.

o        Any capital gain in respect of the payment is also disregarded under Division 855 as shares in Company A are not taxable Australian property.

The Commissioner accepts there is nothing to suggest Company A attempted to preserve franking credits and the dividend payments and franking percentage thereof has remained consistent recent income years.

The majority of Company A shareholders are residents, and for some of those shareholders there may have been an advantage in receiving a return of capital rather than a dividend. However, Company A made the capital return to all shareholders regardless of their tax profile.

The fact that Company A shareholders will reduce their tax liability under the return of capital (as compared to their tax liability if a dividend had been paid) is a factor that inclines towards the existence of the requisite purpose.

Paragraph 177D(2)(e) - any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme

Paragraph 114 of PS LA 2008/10 states:

The most significant financial change for shareholders is that they receive a cash distribution or some other benefit from the company. If the scheme is an equal share capital reduction, the shareholders will receive the distribution with their proportionate interests in the company (that is, their income producing investment) remaining essentially the same. This would point towards the requisite purpose.

Company A shareholders received a return of capital of $XX for each Company A share that they held at the Record Date. They continued to own the same number and proportion of Company A shares.

This factor inclines towards the existence of the requisite purpose.

Paragraph 177D(2)(f) - any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme

Paragraph 115 of PS LA 2008/10 states:

In relation to a share capital reduction the company would generally be the only other party whose financial position will change as a result of the scheme.

PS LA 2008/10 also states:

116. The financial result for a company of returning capital to the shareholders is that it divests itself of that amount of value. A less direct financial result may be that a distribution of share capital would forestall shareholder demand for the comparable alternative of a franked distribution, and, in turn, the need for the company to ensure that it has sufficient franking credits to make such a franked distribution.

117. A share capital reduction may also increase the company's gearing ratio regardless of whether equity is substituted by new debt or existing debt, although the effect is enhanced if new debt is taken on. Practically from a market perspective, as equity can be more expensive than debt (depending on prevailing interest rates), substituting debt for equity can reduce the company's cost of funds, which in turn may increase company profitability, shareholder returns and the share price. Of course, a company's profitability can depend also on a range of other factors.

The return of capital reduced the cash and net asset value of Company A. In the present circumstances, this requires an examination of whether the scheme resulted in a change in the financial position of Company A itself. The only changes to Company A's financial position was a reduction in share capital and a reduction in cash. The immediate effect was that Company A was worth less than it was just before the capital return.

This circumstance does not incline towards a finding that the requisite purpose exists.

Paragraph 177D(2)(g) - any other consequence for the relevant taxpayer, or for any person referred to in paragraph (f), of the scheme having been entered into or carried out

Paragraph 121 of PS LA 2008/10 states:

The decision to reduce share capital as opposed to paying out a dividend may be a consequence of the distribution culture of the particular company. Accordingly, tax officers should have regard to the objective consequences of the share capital reduction on the company with respect to its dividend history and its ability to provide stable dividends in the future. Thus, this provision requires that regard be given to the nature of the company's business and how this impacts on its ability to pay dividends, as well as objective shareholder and 'market' expectations in relation to the company's distributions.

The return of capital is not expected to affect Company A's payment of future dividends as Company A is expected to wind up its operations. Therefore, this factor does not incline towards the existence of the requisite purpose.

Paragraph 177D(2)(h) - the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in paragraph (f)

This factor requires consideration of the nature of any connection (whether of a business, family or other nature) between the shareholders and any person referred to in paragraph 177D(2)(f) - in this case the relationship between Company A and its shareholders.

Paragraph 124 of PS LA 2008/10 states:

... ordinarily that would be the company that is distributing share capital to the shareholders. The connection between the two parties is the relationship of shareholder and company.

According to paragraph 125 of PS LA 2008/10, the company, through its board of directors, manages the corporate business enterprise in the interest of the shareholders who in turn, benefit from corporate distributions. Whether the distribution takes the form of capital or profits is a decision made in the interests of both shareholders and the business.

Company A's decision to make the proposed return of capital was in line with Company A's distributing excess capital following the Sale of the disposed businesses. It was not indicative of an intention to provide a tax benefit to Company A shareholders.

This circumstance does not incline towards a finding that the requisite purpose exists.

Conclusion

Some of the relevant circumstances of the scheme (paragraphs 45B(8)(h) and paragraphs 177D(2)(d) and (e) incline towards the existence of the requisite purpose.

However, having regard to all of the relevant circumstances of Company A's return of capital, the Commissioner considers that the scheme was not entered into or carried out for a more than incidental purpose of enabling Company A shareholders to obtain a tax benefit.

Accordingly, the Commissioner will not make a determination under paragraph 45B(3)(b) that section 45C applies in relation to the whole, or a part, of the capital benefit constituted by the distribution of share capital to Company A shareholders. No part of the return of capital will be treated as a dividend for income tax purposes under section 45B.